The final IFRS IC decision allows companies to choose between the group perspective, View I, and the look-through approach, View II. Based on our experience, many corporate treasurers in companies without specified main business activities are likely to prefer the group perspective.
Many groups already have numerous “natural hedges” in place. Typical examples include offsetting intragroup foreign currency receivables and payables within cash-pooling structures. They also include offsetting operating foreign currency positions held by individual subsidiaries that may be refinanced through the central cash pool.
If all foreign exchange differences arising from these intragroup monetary positions are classified in the operating category, the economic offsetting effects are fully reflected in operating profit or loss. In many cases, existing “natural hedges” can therefore continue under IFRS 18 without the corresponding effects on profit or loss being allocated to different categories in the income statement.
However, companies frequently also include external bank accounts in their “natural hedges”. External bank deposits and bank liabilities are separate financial assets and financial liabilities involving third parties. The resulting effects, particularly foreign exchange effects, would therefore be classified in either the investing or financing category.
Previously, when identifying and managing foreign currency risks, it was not necessary to distinguish between risks arising from a bank account and those arising from a cash-pool account. This approach should now be reassessed. The following considerations are likely to be particularly relevant:
At some companies, bank account balances alternate between a positive and a negative balance over the course of the year. If clearly allocating the resulting foreign exchange differences would involve undue cost or effort, the relief described in the underlying requirements may apply. The affected foreign exchange differences would then be classified in the operating category. Existing “natural hedges” would therefore continue to work under IFRS 18.
If this exception does not apply, foreign exchange effects arising from external bank accounts with positive balances will generally need to be presented in the investing category. In such cases, it may be appropriate to reassess the existing risk management strategy in order to continue benefiting from “natural hedges”. For example, foreign currency balances held in bank accounts could be converted into euros for a defined period using foreign exchange swaps. The derivative could serve as a hedging instrument for offsetting intragroup balances, provided that these balances exist over a comparable period. For the classification of their measurement effects, both designated and non-designated derivatives generally follow the hedged item. This can achieve an offset within operating profit or loss without having to meet the formal requirements of hedge accounting.
In many groups, longer-term deposits or borrowings of a subsidiary within the cash pool are already converted into an intercompany loan or intercompany deposit and hedged using foreign exchange swaps. In these cases, IFRS 18 is unlikely to result in any fundamental need for adjustment. This approach should therefore also be considered as part of the analysis.
The key challenge is therefore not so much the choice between View I and View II. Rather, it is essential to critically reassess and further develop the existing risk management strategy in light of IFRS 18 so that foreign exchange effects and the resulting volatility are appropriately reflected.
